The Domestic Production Activities Deduction (DPAD), sometimes known as the manufacturer’s deduction, is a tax deduction of 9% which can be used to offset net income earned by certain types of domestic production activities. The deduction was created by the American Jobs Creation Act of 2004 for the purpose of incentivizing United States companies to keep jobs and production activities in the United States by providing tax incentives to off-set the benefits of lower wages and production costs associated with overseas manufacturing. Although there has been much debate as to whether this tax break has served its intended purpose due to the continued loss of United States manufacturing jobs since its enactment, the Domestic Production Activities Deduction nevertheless provides a significant tax saving opportunity for business and individual taxpayers whose production activities meet certain specific criteria.
As with many tax incentives, the Domestic Production Activities Deduction is often utilized by larger, more sophisticated companies but overlooked by small to medium sized businesses. It is also underused by companies that are not typically considered to be in the manufacturing industry but which were specifically targeted by the original legislation. In addition to conventional manufacturing, several other activities are considered eligible for the deduction. These include architectural and engineering services, energy production, construction, certain types of film production and sound recording and specific categories of software and video game development. Companies in these industries generally qualify for the Domestic Production Activities Deduction if all or a significant part of their activities occur in the United States. Under the guidelines established by the safe harbor test, a taxpayer is treated as having manufactured, produced, grown or extracted property in significant part in the United States if the direct labor and overhead costs incurred within the United States account for at least 20% of the total cost of the property.
Although the Domestic Production Activities Deduction allows businesses and individuals to offset 9% of any net income that is associated with certain qualifying activities, the total amount of the deduction is subject to certain restrictions. Specifically, it may not exceed the adjusted gross income reported by an individual taxpayer, the taxable income reported by a C Corporation or the sum total of the wages paid by a company in the current tax year. For businesses with only one type of operating activity, determining the amount of the deduction is reasonably straightforward but, for those with different activities and different manufacturing processes, the calculation may involve the more complicated process of tracking revenues and costs for qualifying and non-qualifying activities. This additional layer of complexity often results in eligible taxpayers not taking advantage of the tax benefits it provides. It should also be pointed out that, because this is a deduction rather than a credit, it requires an election allowing it to be calculated in current years and all years eligible for amendment. This being the case, high income taxpayers and taxpayers currently reporting transactions resulting in significant tax liabilities should consider retroactive calculations and amendments as well as current and future applications
The experienced professionals at CGT Solutions have helped many business owners save tax dollars through use of the Domestic Production Activities Deduction. If you are interested in investigating the tax saving opportunities provided by this tax break, our knowledgeable and experienced professionals can provide you with the help you are looking for. Contact us today to arrange a free, no obligation consultation.
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